چکیده انگلیسی

This paper examines the impact of naked short selling on equity markets where it is restricted to securities on an approved list. Consistent with Miller's (1977) intuition, stocks with the highest dispersion of opinions and short sale constraints are the only stocks to exhibit significant and negative abnormal returns in the post-event period. We also find slightly higher stock return volatility and a small reduction in liquidity when naked short sales are allowed. Overall, it impairs market quality (liquidity and volatility), although there appears to be some improvement in price efficiency in stocks with high short sale constraints.

مقدمه انگلیسی

In an effort to stop unlawful stock price manipulation, on July 9, 2008 the Securities and Exchange Commission (SEC) in the United States announced an emergency order to immediately curb naked short selling on nineteen financial firms.1 On September 19, 2008, regulators in the United Kingdom also acted by banning short selling (both covered and naked) on leading financial stocks. The SEC subsequently moved to ban short selling on financial stocks from September 22, 2008 until October 9, 2008. Other markets soon followed and announced their own bans: Australia temporarily banned all forms of short selling and later placed an indefinite ban on naked short selling; Germany, Ireland, Canada, Indonesia, and Greece banned short selling on leading financial stocks; Korea banned short selling on all stocks; France, Italy, Portugal, Luxembourg, The Netherlands, and Belgium banned naked short selling on leading financial stocks; and Japan and Switzerland banned naked short selling on all stocks.
Although short selling has long been a contentious issue (Chancellor, 2001), this latest series of bans on short selling serves to highlight a common concern among market participants over the use of short selling and, in particular, naked short selling. It is interesting to note that while most markets have reinstated covered short selling as a legitimate trading activity, naked short selling remains largely outlawed.2 This is an interesting development as, despite the apparent assumption that naked short selling is detrimental, relatively little or no empirical evidence is available on the impact that naked short selling has on financial markets.
The literature examines changes in the rules governing either covered short sales (Chang, Chang, and Yu, 2007), or changes to short sale constraints that affect both naked and covered short sales (Boehme, Danielsen, and Sorescu, 2006). The purpose of this paper is to bridge this gap in the literature by directly examining the impact of allowing naked short selling on returns, volatility, and liquidity. This opportunity is provided by a unique feature of the Australian Securities Exchange (ASX), which allows naked short sales for certain securities on an approved short sale list that is revised over time. 3 The addition of a security to the designated list of eligible stocks represents a shift from only allowing covered short sales to allowing both covered and naked short sales, thus allowing an isolation of the impact of allowing naked short sales on financial markets.
This shift to naked short selling may circumvent the fee charged by the stock lender, which represents a significant cost associated with covered short selling.4 In addition to this direct cost, there are several risks associated with covered short selling, including the risk of a short squeeze due to an involuntary closure of the stock loan (the short seller is unable to find an alternative supply of stock in the event that the loan is closed). Further, naked short selling circumvents search costs associated with locating and negotiating securities for lending (Kolasinski, Reed, and Ringgenberg, 2010). Together, these costs and risks represent a short sale constraint that could be removed when naked short sales are permitted.
The literature on short sale constraints typically focuses on the effect of such restrictions on asset prices and volatility. Naked short sale constraints could affect the mix of passive and active strategies of short sellers, which could in turn affect liquidity measures such as bid-ask spreads and order-depth. As far as we are aware, there is little empirical or theoretical evidence on how short sale constraints affect liquidity. Alexander and Peterson (2008) and Diether, Lee, and Werner (2009a) are the only exceptions, and examine the impact of short sale price tests on market liquidity. This paper adds to the limited evidence of the impact of short sale constraints on liquidity, in addition to examining the impact of naked short selling on returns and volatility.
Differences between the behavior of naked and covered short sellers may lead to the impact of allowing naked short sales on returns and volatility to differ from that of covered short sales. The possible shorter-term strategy of naked short selling compared to covered short selling may result in changes to volatility at the intraday level, rather than daily.5 Volatility measured over shorter periods, such as 15-minute intervals and trade-by-trade-based measures, contain less fundamental news and are more reflective of transitory price changes due to market structure differences or order imbalances (Bennett and Wei, 2006). Subsequently, we examine the relationship between naked short sale constraints and volatility using daily, intraday, and trade-by-trade based volatility measures.
The results of this study indicate that allowing naked short selling is consistent with Miller's (1977) intuition. Stocks with the highest dispersion of opinions and highest short sale constraints (higher lending fees) are the only ones to exhibit significant and negative abnormal returns in the post-event period. We also document slightly higher stock return volatility and a small reduction in liquidity (wider bid-ask spreads and effective spreads) when naked short sales are allowed. However, the magnitude and significance of this result is dependent on the level of the short sale constraint. The impact of naked short selling is greater, both in magnitude and significance, for stocks with higher lending fees (more short sale constrained). Stocks with relatively low lending fees experience smaller or no significant change from the introduction of naked short sales. This is consistent with the notion that stocks with lower lending fees experience relatively little naked short selling since covered short selling is less expensive.
Further analysis reveals that the increase in the bid-ask spread is driven by higher adverse selection costs. This is consistent with the notion that short sellers are informed traders. Examination of the securities lending market reveals that the demand for securities lending is reduced following the introduction of naked short selling. Given securities lending is a commonly used proxy for the level of covered short selling (D'Avolio, 2002), this implies that there is a significant reduction in covered short selling for stocks added to the designated list of eligible stocks. Overall, allowing naked short selling impairs market quality (liquidity and volatility), but there appears to be some improvement in price efficiency, with the results predominantly limited to stocks with high short sale constraints.
The remainder of this paper is organized as follows. Section 2 reviews the literature on short sale constraints. Section 3 describes the institutional details for short sales on the ASX. Section 4 reports the data, sample selection, and the empirical analysis of the impact of naked short selling on returns, liquidity, and volatility. Section 5 provides a summary of the main results and conclusions.

نتیجه گیری انگلیسی

In this study, we examine the impact of allowing naked short selling on the securities lending and equity market in a unique market setting where naked short sales are restricted to certain securities on an approved list. Consistent with Miller (1977), stocks with the highest dispersion of opinion and highest short sale constraint are the only stocks to exhibit significant and negative abnormal returns in the post-event period. These stocks experience a −3.415% abnormal return on the event date, significant at the 1% level.
We also examine the impact of allowing naked short selling on volatility and liquidity using both a matching and regression discontinuity design. The results, consistent across both methods, reveal a small increase in the daily and intraday volatility of individual stock returns. Further, allowing naked short selling leads to small reductions in liquidity via increased transaction costs (wider bid-ask spreads and effective spreads). However, the magnitude and significance of this result is dependent on the level of short sale constraint. The impact of naked short selling is greater, both in magnitude and significance, for stocks with higher lending fees (more short sale constrained). Stocks with relatively low lending fees experience smaller or no significant change from the introduction of naked short sales. This is consistent with the notion that stocks with lower lending fees experience relatively little naked short selling since covered short selling is less expensive.
Using the Lin, Sanger, and Booth (1995) spread decomposition model, we attribute the increase in bid-ask spread to an increase in the adverse selection component of the spread. This is consistent with the notion that short sellers are likely to be informed traders. Analysis of the securities lending market reveals that the demand for securities lending is reduced following the introduction of naked short selling. While not providing conclusive evidence, naked short selling appears to occur once stocks are added to the list of eligible stocks. Therefore, the results can be attributed (at least in part) to the introduction of naked short sales.
Overall, the results should be of interest to policy makers, who have recently moved towards curbing naked short selling. We provide some support for these moves, with the evidence suggesting that allowing naked short selling impairs liquidity and slightly increases stock price volatility. However, there appears to be some improvement in price efficiency, and the results are predominantly limited to stocks with high short sale constraints.